Can Simcere Pharmaceutical Group Limited (HKG: 2096) maintain good returns?
Many investors are still educating themselves about the various metrics that can be useful when analyzing a stock. This article is for those who want to learn more about return on equity (ROE). We will use the ROE to take a look at Simcere Pharmaceutical Group Limited (HKG: 2096), using a real world example.
ROE or return on equity is a useful tool to assess how effectively a company can generate the returns on investment it has received from its shareholders. In short, the ROE shows the profit that each dollar generates compared to the investments of its shareholders.
See our latest analysis for Simcere Pharmaceutical Group
How is the ROE calculated?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE for Simcere Pharmaceutical Group is:
12% = CN Â¥ 664m CN Â¥ 5.3b (Based on the last twelve months up to December 2020).
The “return” is the income the business has earned over the past year. Another way to look at this is that for every HK $ 1 worth of shares, the company was able to make HK $ 0.12 in profit.
Does the Simcere pharmaceutical group have a good ROE?
A simple way to determine if a company has a good return on equity is to compare it to the average in its industry. The limitation of this approach is that some companies are very different from others, even within the same industry classification. As shown in the image below, Simcere Pharmaceutical Group has a better ROE than the pharmaceutical industry average (10%).
This is what we love to see. That said, high ROE doesn’t always indicate high profitability. A higher proportion of debt in a company’s capital structure can also result in high ROE, where high debt levels could represent a huge risk. You can see the 3 risks we have identified for Simcere Pharmaceutical Group by visiting our risk dashboard for free on our platform here.
Why You Should Consider Debt When Looking At ROE
Almost all businesses need money to invest in the business, to increase their profits. This liquidity can come from the issuance of shares, retained earnings or debt. In the first and second cases, the ROE will reflect this use of cash for investing in the business. In the latter case, the debt necessary for growth will increase returns, but will have no impact on equity. This will make the ROE better than if no debt was used.
Combine the debt of the pharmaceutical group Simcere and its return on equity of 12%
Although Simcere Pharmaceutical Group uses debt, its debt ratio of 0.58 is still low. The fact that she achieved a fairly good ROE with only modest debt suggests that the business might be worth putting on your watch list. The prudent use of debt to increase returns is generally a good move for shareholders, even if it leaves the company more exposed to interest rate hikes.
Return on equity is a way to compare the quality of the business of different companies. A business that can earn a high return on equity without going into debt could be considered a high quality business. If two companies have roughly the same level of debt to equity and one has a higher ROE, I would generally prefer the one with a higher ROE.
But when a company is of high quality, the market often offers it up to a price that reflects that. Especially important to consider are the growth rates of earnings, relative to expectations reflected in the share price. So I think it’s worth checking this out free analyst forecast report for the company.
If you would rather consult with another company – one with potentially superior finances – then don’t miss this free list of interesting companies, which have a HIGH return on equity and low leverage.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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